Asset allocation is one of the most important factors to consider when building a cryptocurrency. And financial advisors all recommend one thing when it comes to asset allocation:
The reasoning is simple enough. You do not want to place all your eggs in one basket. If one asset collapses, then a diversified portfolio will offset that collapsed asset.
However, diversification applies to stocks and bonds where volatility is less and there is more standardization across assets. As you probably know, cryptocurrency operates on a different set of rules than stocks and bonds.
With that in mind, diversification of your cryptocurrency portfolio might not be the best option.
This article will go into detail about the different types of asset allocation in cryptocurrency and which strategy will work best for you.
Does diversification actually work for a cryptocurrency portfolio?
Most people know that a diverse stock portfolio works better than picking a single stock. In fact, it’s generally considered unwise to place your entire portfolio in one asset class, let alone a single stock, in traditional finance.
Many people believe that this same concept applies to cryptocurrency, but the evidence does not support that hypothesis.
All it takes to realize this is that Bitcoin has seen a 94% increase in price since January 1st, 2018 while no other altcoin has come close to that percentage increase. In fact, all the most popular altcoins have seen a price decrease in that time span.
Of course, this is a biased data point because it began immediately before altcoins collapsed in February 2018.
However, Bitcoin still comes out ahead when the beginning of the altcoin is factored into the diversification equation.
The Problem with Altcoins in a Diversified Portfolio
The biggest problem with altcoins in a diversified cryptocurrency portfolio is that the returns are simply not high enough. Sure, some altcoins have high returns, but those high returns are minimized by the vast majority of altcoins that go to zero.
In that regard, altcoins are essentially gambling. It’s better to consider altcoins as a gambling strategy rather than as part of your cryptocurrency portfolio. This is especially true for altcoins that are longshots – they are likely to go to zero than have 1000% returns. And if they do have 1000% returns, you should realize the gain before the price crashes.
What if Bitcoin collapses and I’m not diversified?
A common retort to not having a diversified cryptocurrency portfolio is, “What if Bitcoin collapses?”
The response is simple. If Bitcoin collapses, then the entire cryptocurrency industry will collapse because Bitcoin is the cryptocurrency industry in a financial sense and an awareness sense.
From a financial perspective, cryptocurrency has a total market cap of about $550 billion USD. Bitcoin makes up $343 billion USD of that market cap, which is a little under 70% of the total cryptocurrency market cap.
With that in mind, if the price of Bitcoin craters, then the price of every other cryptocurrency will also drop. This is especially true because most altcoins are sold in a Bitcoin trading pair.
The other part of this is that Bitcoin is synonymous with cryptocurrency. Due to that, a collapse of cryptocurrency will result in the destruction of the cryptocurrency brand.
In other words, it would mark the end of cryptocurrency. It would be a similar situation to the Hindenburg disaster causing an end to rigid airship travel.
When a diverse cryptocurrency portfolio makes sense
With all that in mind, a diverse cryptocurrency does make some sense in certain situations. Here are the situations.
You Want Maximum Exposure to Cryptocurrency
The situation that a diversified cryptocurrency makes the most sense is if you want maximum exposure to cryptocurrency. Now, the evidence suggests that altcoins do not make a good investment in a diversified crypto portfolio, but past performance does not indicate future results.
This is especially true in cryptocurrency where it appears that altcoins, and cryptocurrency in general, have an upward trajectory from a financial perspective and from a perception perspective.
It’s undeniable that cryptocurrency has entered the mainstream consciousness. It’s also true that altcoins have exploded in price since their inception 7 years ago. The difference is that Bitcoin has gone up much more than altcoins as a whole, but Bitcoin’s gains may begin to slow as the price continues to rise to higher levels.
You Have Strong Faith in Altcoins
The other situation where a diverse cryptocurrency portfolio makes sense is if you have more faith in altcoins than Bitcoin. This can be for many reasons – many people simply do not like Bitcoin.
Of course, this reason is based on nothing more than faith and a hunch. The evidence does not support this asset allocation, but this is reason enough for many people to diversify their cryptocurrency portfolio.
What is a good cryptocurrency portfolio allocation?
Our recommendation is to have most of your holdings in Bitcoin. Again, past performance does not indicate future success, but Bitcoin is generally regarded as the safest cryptocurrency investment because it has the largest market share (nearly 70%).
Some investors place 100% of their portfolio in Bitcoin while others place 50% in Bitcoin and the rest in altcoins.
If you do decide to invest in altcoins, then going with the top 10 altcoins by market cap is a safe bet. However, some altcoins such as Bitcoin Cash and Tether can be ignored. That leaves us with the following altcoins:
- Ethereum (ETH)
- Ripple (XRP) – compare with Stellar (XLM)
- Litecoin (LTC)
- Chainlink (LINK)
- Cardano (ADA)
- Polkadot (DOT)
Is a diverse cryptocurrency portfolio right for me?
This depends on your risk profile and knowledge of altcoins. If you have some altcoins that you believe will rise in value, then it makes sense to diversify your crypto portfolio.
On the other hand, if you are unknowledgeable about cryptocurrency, then it’s probably best to just keep your crypto portfolio in Bitcoin with a handful of cheap altcoins that have the potential to increase by over 1000%.
How much crypto should I keep in my financial portfolio?
You probably have a standard financial portfolio with stocks, bonds, gold, and possibly even real estate.
Cryptocurrency is at the level where it does make some sense to allocate some of your financial portfolio to cryptocurrency. Cryptocurrency is obviously a risky investment, so we don’t recommend more than 10% of your financial portfolio to be in cryptocurrency.
When will a diversified cryptocurrency make financial sense?
At the moment, Bitcoin makes up nearly 70% of the total cryptocurrency market cap.
That’s far too high for diversification to make financial sense. You’re better off just putting your entire portfolio into Bitcoin.
However, once Bitcoin makes up only 40% of the total cryptocurrency market cap, then it will make sense to diversify your cryptocurrency portfolio. The volatility should decrease at that point and there will be stable altcoins as well.
That covers it for asset allocation in cryptocurrency. It’s actually pretty easy to allocate cryptocurrency assets – just put everything in Bitcoin with maybe a few low value altcoins that have the potential to increase in price by over 1000%.
It simply has not been as profitable to have any of your cryptocurrency allocated to altcoins since the inception of Bitcoin.